Assignment#2: MGT201

Student I.D: mc070400942

Solution Question No.1
In order to find β, we will use the Gordon-SML equation:
Po*=DIV1/ [{rRF+ (rM-rRF) β} – g]

Po*=80
DIV1=5
g = 7%=0.07
rRF=6%=0.06
rM=10%=0.10

By putting these values in the equation we will solve for β

Po*=DIV1/ [{rRF+ (rM-rRF) β} – g]
80=5/ [{0.06+ (0.10-0.06) β} – 0.07]
80=5/ [0.06 + .04 β – 0.07]
80=5/0.04β – 0.01
(OR)
0.04β – 0.01=1/80 (5)
0.04β – 0.01=0.0625
0.04β – 0.01+0.01=0.0625+0.01
0.04β = 0.0725
0.04β/0.04=0.0725/0.04

Beta (β) = 1.8125 Answer

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Solution Question No.2

In case of Bond A: (Part a)

Coupon Payment=PMT=10/100x2000=200
Interest=14%=0.14
N=3 years
In Order to find its value we can also use the annuity formula with simple
PV to discount the Par Value since it is helpful if the time period is long:

PV=PMT [1/i-1/i (1+i) ^n] + FV (Par Value)/ (1+i) ^n

PV=200[1/0.14 – 1/0.14(1+0.14) ^3] + 2000/ (1+0.14) ^3
PV=200[7.1428 – 1/0.14(1.14) ^3] + 2000/ (1.14) ^3
PV=200[7.1428 – 4.82] + 2000/1.4815
PV=200 x 2.3228 + 1349.9831
PV=464.56 + 1349.9831
PV=1814.53 (Thus, 1814.53 is the value of Bond A)
In case of Bond B: (Part b)
Coupon Payment=PMT=10/100 x 2000=200
Interest= 14%=0.14
N= 5 years
In Order to find its value we can also use the annuity formula with simple
PV to discount the Par Value since it is helpful if the time period is long:

PV=PMT [1/i-1/i (1+i) ^n] + FV (Par Value)/ (1+i) ^n

PV=200[1/0.14 – 1/0.14(1+0.14) ^5] + 2000/ (1+0.14) ^5
PV=200[7.1428 – 1/0.14(1.14) ^5] + 2000/ (1.14) ^5
PV=200[7.1428 – 3.7097] + 2000/1.9254
PV=200 x 3.4331 + 1038.74
PV=686.62 + 1038.74
PV=1725.35 (Thus, 1725.35 is the value of Bond B)

(Part c)
Both of the bonds are similar in nature except the time to maturity, Bond A is
more desirable as its maturity date is nearer as compared to Bond B. So far as
interest rate risk is concerned, the shorter maturity period bond has tendency to
minimize the interest rate risk i.e. Bond A.